Western Digital Corporation (WDC) Earnings Call Transcript & Summary

Good afternoon or morning, everybody. I'm Aaron Rakers, I'm the IT hardware semiconductor analyst here at Wells Fargo. We're pleased to host a discussion with the CEO and CFO of Western Digital. First of all, David and Bob, thanks for joining us today. I appreciate the time.

Absolutely. Aaron, it's great to be here.

Yes. Happy to be here.

Perfect. So I apologize, we're starting a few minutes late, so I'm going to try and talk maybe a little bit faster here.

Okay.

But David, I'd love to just kind of kick off. You've made some kind of moves over the past few months, past quarter or so around just the structure of the Flash business, the hard disk drive business. And so, I guess let's, start there. How are you thinking about the structure of the company, the structure of the businesses, hard drive versus flash? And the moves that you've recently made?

Aaron, before we get too far along, I just want to do the safe harbor. So we will be making forward-looking statements, and I ask you to refer to our SEC filings for the risks associated with these statements. We will also be making references to non-GAAP financials and a reconciliation of our GAAP and our non-GAAP financial results can be found on our website. With that, I'll turn it over to Dave.

All right. Aaron, a fantastic place to start with the structure of the business because it is really important. So when I got here back in March, I spent a lot of time thinking about the business and understanding how we were organized, the markets we're in, our customers, where the synergies are in the business and how well we were executing and what's going to put us in the best position to take advantage of the great markets we're in going forward. And I didn't think we had the right -- we had the optimal organization structure. We kind of had everybody rolling up to a COO type structure and then the layer below that, you had an engineering leader, a product leader and operations leader. And everybody at that level was involved in the HDD business and the Flash business. They're both very, very -- the folks -- they're both very big businesses for us. They both have their own sets of competitors, technology areas to focus on, road maps, investment levels, ways to measure them. And I just thought better focus on each portfolio was what we needed and that the primary synergy of the 2 franchises is through the go-to-market. We sell them through a common customer. We can bring a larger solution to those customers, especially the hard drive business gives us an anchor position with the cloud titans that is really, really advantageous. And those customers are big consumers of flash, not only in their data centers, but a lot of them have big consumer franchises as well, and we had the ability to leverage those relationships to play into those businesses. But I thought on the technology side, we really needed more focus. To execute really well, you have to have focus. And we went to a business unit structure, where we could drive accountability for each business, lower in the organization. So we brought together engineering and product management and product strategy for each business, HDD and flash. We've now brought in 2 very, very experienced general managers that will be responsible for driving those businesses forward. Rob Soderbery for the Flash business and Ashley Gorakhpurwalla, who just joined us a couple of weeks ago now for the HDD business. So I think very quickly, we announced this structure and got 2 scale leaders in place, 2 individuals that have run franchises that are as big as our whole company, quite frankly. And so they're forming the teams, they're getting the focus on -- Rob on the Flash business, Ashley, on the HDD business, execute the road map, decide what markets we're going to play in, the money we're putting into those business, what's the best way to allocate that in the portfolio and then drive the execution of those portfolios. Then of course, they come together through a common go-to-market organization in front of the customer. So I thought -- I think that we've evolved to the structure very quickly, quite frankly, and got 2 very -- as I said, very, very good leaders in place over the last couple of months, and I feel really good about where we're at, and we're seeing the -- I'm seeing the increased focus already in these businesses in delivering in the markets they play in. And let me just say one more thing about it. Another thing it brings to us in addition to the technology leadership, P&L leadership, very strong business leaders, it's 2 very more -- 2 very senior people that are very used to dealing with customers at a very, very high level and a strategic level. And again, so both Ashley and Rob are in their businesses, talking to customers very, very frequently with our go-to-market teams and driving the portfolio forward.

That's great, David. And one of the things you brought up on the last earnings call because you've made these moves and I, of course, get a lot of questions about that integration or that synergistic elements of keeping the 2 businesses as 1. You emphasized selling hard drives to end customers, that most of your customers buy both from Western Digital. But not to be blunt, but you struggled a bit in enterprise SSDs, right? And so I guess my question is, is the story different there on the enterprise SSD side? Or with 100 qualifications noted in the last quarter in enterprise SSDs, is it just a matter of time? Or how should we think about an improved execution side of the enterprise SSD business?

Yes. So there's a lot in that question. Let's unpack it a little bit because I think there's a lot of really, really good material in there. So first of all, you're right. As we talked about on our earnings call, all 20 of our top 20 customers buy from both sides of the house at different levels of intensity, but all of them buy both parts of the portfolio. And I think that, that kind of crystallizes that go-to-market synergy that we have. And in some markets, the dynamics between the portfolio are different in different markets. I mean, one area that we've done quite well on is client SSD. And that's an area where you see the SSD essentially being a replacement for the HDD in the device. And we've been able to play that transition because we had great relationships with the OEMs that are building the PCs and the laptops and we can -- we understand the requirements on the product, all those kinds of issues, and we can play that transition, and that's worked out very well for us. On the enterprise SSD side, the first generation product we have I don't think lived up to what we wanted it to be. We've built a second-generation product now. We feel very good about that. As you said, we're in 100 qualifications, we've got qualifications slots. We're either in process, we're lined up at a number of the cloud titans. Obviously, those are big prizes for us to get those. There's a lot of consumption there. But we feel good about where the product is. We've got to finish the qualifications. I view the qualification cycle as part of the development process. It's the final stage where you're working in the customer environment, you're going through the iterative process to make sure the product meets exactly what the customer needs. And we're going through that with one of the big cloud titans right now, and where we have slots lined up at the others throughout '21. So it's going to be an evolving story. But we feel better about where the product is. And I think this goes back to why I put the organization in place. I think we now have the focus in the senior technology and engineering and product leadership to drive success and going to have the focus that's required to execute in these very, very sophisticated markets. So I feel good about where we're at. And as we go through '21, I think the picture will get better. I will also -- I'll just make one more comment again because I said, Aaron, there's a lot in your question. Also remember that a lot of these customers, especially on the cloud titan side, there's enterprise SSD opportunities, but these customers also have other big portfolios, whether it's consumer-facing portfolios in gaming, home automation, autonomous driving, VR headsets. So we have the opportunity to leverage that go-to-market and customer relationship into a much broader part of the market in addition to enterprise SSD.

That's great. And is that market -- is that inertia around driving revenue? And again, I think your share was fairly small this last quarter in enterprise SSD. Is that something that's like an 80-20 rule where 20% of those customers make up 80% of the market opportunity? And if so, when do you think that the majority of those 20% might be consuming in volume at this point?

Yes. I mean, well, there's certainly -- I mean, it's like any parade of any market. There are some customers that are bigger than other, and the cloud titans are obviously huge customers. And so -- and I talked about that in our earnings call that we've been transparent about we're lining up when the quals are going to start. They're long processes, they can take from 3 to 9 months depending on the customer. And as we work through those, we will have more TAM available to us as we get those qualifications done. However, I don't want to minimize the rest of the market. I mean it's a big market out there. It's a big world. The fact that we have 100 quals completed says a lot about the integrity of the product, and we're going to continue to push qualifications across our entire -- all the avenues that we sell into the market.

Okay. Shifting gears to other cloud-driven element in the business, the nearline hard disk drive business. I mean, there's -- depending on who you listen to or what you watch, the cloud is strong, cloud is digesting some of the capacity footprint. So as we stand here today, as we think about the demand profile for nearline, how -- what's the current view as we think about calendar '21? Is it -- to the extent you can share with us right now?

Yes. So I think we talked about it going into calendar Q3 about digestion, going into a digestion phase. And we're in that, we see us coming out of that in '21. I think there's a lot of reasons to feel positive about '21 when we talk to our customers. I think it will get better as the year goes on. I think we're come -- the pandemic has clearly accelerated the digital transformation, if you want to call it that, the way all of us use the cloud every day and the devices we use and our -- whether it's -- however we lead our life. I think we don't know what the new normal is coming out of this, but I would say pretty confidently that, that new normal is going to be more use of technology than less coming out of it. So -- and I -- so I think that situation gets better throughout '21, and that's what we hear from our customers as well.

And can you talk a little bit about road map, 18-terabyte, 20-terabyte CMR? Is 20-terabyte CMR -- is that something we should be thinking about in the next year? Or just how you stack up -- you think you stack up competitively in the nearline market?

Yes. Well, we're laser-focused on 18 right now. Obviously, in any kind of big portfolio, you're building multiple iterations of technology. We'll talk about the 20 when we're ready to launch it. We feel that project is something that's on track. We know what the design looks like. But we're very, very focused on getting 18 rolled out. I think we're now at 138 completed qualifications on our 16, 18 platform. We have another 125 in progress. So it's going according to plan. We're working through it. We feel good. It's always we want to be in a leadership position at capacity points. It gives us more influence over the pricing. It allows us to deliver a better TCO to our customers. And I think as we emerge on that at 18, we're going to see that continue into 20. That's certainly our plan. But we'll talk more about 20 when we get closer to the product.

That's helpful. On the NAND side, Bob, I'd love to kind of -- one of the things that was emphasized earlier this year, was the cost efficiency or cost effectiveness of BiCS5, the 112 layer. We recently saw one of your competitors launch a 176 layer, emphasizing a small die size. So how do you think about the NAND flash cost curve that you could execute on vis-a-vis the BiCS5 transition? And how that stacks up, if you will, or have any thoughts around the competitive landscape?

Yes. So first of all, I mean, we're still very bullish on our BiCS5, 112 layer product. It does have a small die size. And I think the team did a great job in terms of optimizing not just on cost, but on capital as well. So it's very efficient from a CapEx standpoint. And we'll start to see more volume on BiCS5 as we go through 2021, and that clearly is part of what's going to enable our ongoing cost reductions. And we've said for a while, for a number of quarters, we've been executing on a basic plan to reduce costs by about 15% on a year-over-year basis. Some quarters were better than that, some quarters were not quite as good, but we're very confident we can continue to reduce costs by 15% year-over-year. And we think that's extremely competitive. You never know for sure. You don't know what your competitors' yields are versus our yields and so forth. But we're pretty confident that we've got a leadership cost structure.

Aaron, if I could comment on this one real quick. I mean, I think this is one where, I guess, sometimes maybe our JV is underappreciated from what I've seen in that between us and Kioxia, we collaborate both on memory development. We have the same road map. Our teams work hand-in-hand. And obviously, we have the fab -- the production side of it as well. But together, we're the largest supplier in the market. And so that gives us the ability to invest aggressively in a road map for technology. And that gives -- as Bob said, that gives us a lot of confidence that our road map is very, very sound. We're going to lead on cost. We're going to be where we need to be to -- on the cost side of the portfolio. So it's something we continue to invest in very heavily, and we feel very good about where we're at.

Right. And on that same topic, I know one of your competitors preannounced pretty positively this morning, hard to say whether that was DRAM versus flash driven. But your current thinking on the NAND class market, we've kind of been executing through this element of oversupply. You've seen recent moves around consolidation. So how are you currently viewing the supply/demand equation in NAND flash? And would you be able or are you willing to kind of call when do you think maybe that oversupply situation kind of works itself fully out?

Yes. It's tough to call the bottom in that market. But we see a lot that -- we talked about this on our last earnings call, I mean, we see the spot market. We've seen retail been pretty stable now for some time, and retail has been a strength for us and continues to be. We feel good about that. If you look at the macro situation, the gaming cycle has started, and it's been strong. We've got 5G. We talked about the cloud. Certainly on capacity enterprise, we have a lot of visibility in what's going to happen in the cloud and feel good about that. We think that will translate into enterprise SSD at some level. So I think as we go into '21 -- and we think the industry has been pretty good about CapEx investment over the last couple of years to try and keep things balanced. So we feel good about '21. I mean, calling a particular quarter is always tough. But as we go into 20 -- also the pandemic is raging right now. Obviously, we're all very focused on that. But at least now we're talking about vaccines and we're -- at least hopefully, we can see -- start to project that things are going to get better at some point here. So as we look into '21, we see a lot of things to like.

Perfect. And Bob, just kind of, in a couple of minutes we have left here, model kind of variables to consider. Gross margin obviously is a function of price and cost down on the NAND flash side. But you are carrying some, hopefully, I would assume, transitory elements to the gross margin line. Can you talk a little bit more about the lift-out effect or thoughts around COVID-related charges, COVID-related expenses that you're seeing? And then also the progression of how we think about the K1 cost. But I think in total, these equated to like $0.30 of EPS impact this last quarter.

Yes. No, you're right, Aaron. There are significant factors certainly in the short term. On the COVID-19 side, it's really our drive impact. This doesn't really affect flash very much. And it's largely logistics costs at this point in time. And unfortunately, we don't see those getting better anytime soon. It turns out there's a lot of freight that goes on passenger aircraft and with not as many flights coming in from Asia has really caused elevated freight rates. So we think we're going to have elevated logistics costs due to COVID-19 for at least a couple more quarters. The -- I don't know when it gets back to -- when's the vaccine and when do we start to get back to normal, but I think that's going to be with us for a while. On the more positive side, on the K1 costs, we are going to see those coming down. We said they'll be around $50 million this quarter. And then after that, we really think they're going to be immaterial going forward. And so we're not going to be talking about it as we move forward. I think we're kind of through the ramp-up phase where we're getting to normal production volumes, and that will be behind us.

Okay. That's perfect. And then same kind of question maybe not specific on transitory elements or impacts, but operating expenses. Company has done a pretty good job executing on that front. Is there anything that we should think about? Is it structural changes that you've been implementing? Or anything that we should consider around the operating expense trajectory for the company?

Yes. I think if anything, OpEx is unusually low right now. Of course, there's not much travel associated with the business. There are a lot of discretionary expenses, variable expenses that we're just not incurring right now. So I think we'll be kind of in the $700 million range. And I think we guided $680 million to $700 million, if I remember right. And I think that's probably going to be a low. And it will be just a matter of as we go back to normal, you'll see OpEx come back up. And it's probably more in the $710 million, $720 million range. I don't see it staying below $700 million.

Okay. That's very helpful. And then kind of simple question, sustainability of positive free cash flow. How do you think about that? How do you manage that for the business?

Well, I'm constantly beating the cash flow drama, and it's a team sport. So it's all the way around from making sure we're doing a good job on collections, making sure we're getting good forecasts and building the right amount of inventory, that we're managing our supplier terms, that just every person in the company is really thinking about what they can do to conserve cash as best as possible. And I think we've done a very nice job over the last few quarters in a variety of environments of continuing to generate positive free cash flow. So that's our goal. It's going to be a little tough in the short term because we're going to make the long-term investments that we need to make. We've said that's our top priority in terms of use of cash is to reinvest in the business. And then to the extent we have additional cash available, we're going to lower our debt, as we've said.

Yes. And remind us again that targeted kind of level of net debt that you're focused on.

Yes. I mean, we said we'll reevaluate our dividend and return of capital policy with shareholders once we get our net debt down to $3 billion and our gross debt down to $6 billion.

Okay. That's perfect. I rattled through a lot of the questions I have, but I guess one other question I tend to get a lot, in the couple of minutes we have left, I always seem to get the question about the oligopolistic or duopolistic nature of the hard disk drive industry, right? And especially now in hard drives where you got 60-plus-percent of the market going into the nearline HDD market. So that really gets to more of a duopolistic nature competitively. So in that context, I guess the question is, are you surprised that we still see some of the pricing down in the market? Is that a function of just kind of keeping the balance between NAND flash encroachment upon nearline hard drives? Or how do you think about the price curve of hard disk drives in, again, that context to really duopolistic, competitive landscape?

So first of all, I would say it's a very dynamic market, no matter the structure of it. It's a growing market. There's also a lot of concentration on the buying side of it. But -- and it's not an issue of NAND encroaching on HDD. I don't see that as a kind of running both businesses. I don't see that as any impact on the HDD business. It's just about maintaining -- part of it is maintaining discipline on the pricing side of it, right? And I think leading on capacity points allows us to do that. I also think the business is returning to growth now. I mean, there's been a lot of invested capital in this business that needs to be absorbed as we've transitioned away from a lot of client business. I think that era is kind of coming to an end. And as we go into mainly growth through capacity enterprise business where you have -- we have drives now at 9 platters, you need 18 heads. So there's a lot of stuff that goes in. And as that becomes now the major driving element of the portfolio, it's going to require some more investments. So like just running the business for return on invested capital is changing to a different calculation. And so I think there's some natural drivers that the business is going to shift and there's going to be more decision making on how much capital we'll put in this business, which is going to keep the supply and demand in balance. And so I think it's a business that's been around a long time. It's gone through an enormous amount of consolidation, to your point. And it's also the major customer use case has changed dramatically. I mean, it's gone from a device to now the foundation of the cloud. And the public cloud is growing at such an enormous pace off of such a huge base that now fueling that growth is going to be, I think, a different dynamic in the way the businesses are managed and the financial performance of them. It's not going to happen overnight, it's not going to happen in 1 or 2 quarters. But it's a technology that's going to be very, very, very necessary as the foundation of the cloud for years to come. And I think you're seeing that dynamic change as the business turns from this decline of client now to growth of capacity enterprise or nearline.

And the final question on that topic is with everything you just said, David, and kind of this motion around return of invested capital. Is there anything that's changed your thought process around the hard drive business being a 30% plus gross margin? Bob, I don't know if the question is for you or David or how you're thinking about gross margin profile, hard drive.

Yes. My guess is we have the same answer.

Yes, I would probably...

We definitely think capacity enterprise can have gross margins in the mid-30s, and we're going to continue to try and have a portfolio and execute to it so we can deliver on that. And as capacity enterprise becomes more and more of the total business, it's going to pull hard drive margins up in [ any way ].

Yes. That's perfect, guys. I think we exhausted all the time I had. I really appreciate your time, David and Bob, and have a great rest of your day.

All right. Thank you, Aaron. We appreciate it.

Thank you guys. Bye-bye.

Take care.

[ Stay safe ].